November 1, 2019
NeoPhotonics sounds like it should be a Kraftwerk-like band, pumping out electronic music in the bowels of some warehouse-cum-nightclub. In that case, it would probably be The NeoPhotonics, of course.
The actual NeoPhotonics is a relatively obscure (outside industry circles) maker of optical components that was thrown into a different sort of limelight earlier this year when Huawei, its biggest customer, was banned from the show.
Arguing the Chinese manufacturer of telecom network equipment is a threat to national security, US authorities introduced rules to stop it from buying US components. NeoPhotonics, which derived 46% of its revenues from Huawei in 2018, issued profit warnings and saw its share price fall from $6.86 at the start of May to $3.89 by the end of the month. For a while it looked like the NeoPhotonics band might break up or be absorbed into another group.
Critics are a lot more positive today. The company's share price opened at $7.50 on the New York Stock Exchange this morning, up 14% on the previous day's closing price, and was trading at its highest level since February after analysts cheered its latest performance for the fiscal third quarter.
After running up a net loss of $8 million in the June-ending quarter, NeoPhotonics turned a profit of $1.3 million. At $92.4 million, sales were 13% higher than in the year-earlier quarter, after they had grown just 1% year-on-year for the second quarter. The gross margin soared from 19.2% to 28.4% sequentially. What explains the apparent turnaround?
For one thing, the trade sanctions against Huawei do not look as damaging as investors originally feared. Loopholes in US export regulations mean not all NeoPhotonics products are subject to a ban. While the share of Huawei business has fallen, sales to the Chinese vendor still made up 37% of total third-quarter revenues.
"Huawei looks to be committed to NeoPhotonics technology, even though it is prohibited from buying the newest stuff," said Michael Genovese, an analyst with MKM Partners who tracks the US components company, in a research note. "It is a testament to NeoPhotonics that its older-generation products are still important to Huawei."
Indeed, despite insisting it has alternatives to NeoPhotonics, Huawei suddenly seems crazy for its gear. Fear the US might seek to address those loopholes seems partly responsible, as the Chinese equipment giant tries to stockpile components. Yet end-market demand was so strong that Huawei was unable to build inventory in the third quarter. "We don't really know what was sold through in demand versus what's inventory buffer," said Elizabeth Eby, the chief financial officer of NeoPhotonics, during a call with analysts about the recent results.
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Business with other customers has soared, partly because Huawei's behavior has spurred a response in both Chinese and Western markets, says Genovese. "Huawei and other Chinese OEMs [original equipment makers] may want inventory because of the uncertainty of the trade situation. Western OEMs may want inventory to guard against sudden demand spikes, and because the trade situation is adding risk to procurement," he says. "In other words, if the Chinese vendors build inventory, the Western vendors may also have to do it for strategic and competitive reasons."
The backdrop to all this is strong demand in the market for metro and data center equipment. How long that lasts is unclear, because normal "seasonality" factors mean demand is likely to fall in the first half of next year, according to MKM Partners. And no company so heavily dependent on a single customer can feel entirely comfortable when that customer is under sustained attack from US authorities. NeoPhotonics is a big hit right now, but it could fast become unfashionable.
— Iain Morris, International Editor, Light Reading
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